What Is The Dow Jones Industrial Average And What Does It Measure?
THE TAKE-AWAY: What is the Dow Jones industrial average? It gauges the stock performance of 30 really big, household-name U.S. companies deemed to be representative of the U.S. economy.
If you watch the news, perhaps you know that the Dow Jones industrial average, or the Dow, is a thing that rises, falls, swoons, surges, plunges, rallies or tanks. When it tanks, it’s very bad and very important. It drives men in decorated sport coats, the vibe of which is somewhere between executive and airline captain, to bury their heads in their hands and leave paper all over the floor.
What Is The Dow Jones Industrial Average?
You’d be forgiven for not knowing the finer points of what the Dow Jones industrial average actually is. The Dow Jones industrial average is an index that gauges the stock performance of 30 large, well-known companies. A stock index is a compilation of any number of stocks — with different prices, moving in different directions — represented by a single number.
You already know many of the stocks that are part of the Dow. Apple (AAPL), Nike (NKE) and McDonald’s (MCD) are part of the Dow. General Electric (GE), the last original member, will be replaced by Walgreens Boots Alliance (WBA) on June 26, 2018.
What Is The Dow Jones Industrial Average’s Origin?
Created in 1896 to bring more transparency to the stock market, the Dow intends to offer a big-picture view of how the economic, business and political climate might affect big companies seen as bellwethers for the U.S. economy.
How Do They Figure Out The Dow Jones Average?
The Dow is not a physical place, like a trading floor, where people go to buy or sell stocks. When you see pictures of traders pointing, yelling or despairing, they’re probably on the floor of the New York Stock Exchange.
The “Dow” in “Dow Jones” is also completely different Dow from the Dow in the chemical giant DowDuPont. However, DowDuPont (DOW) is a Dow Jones Industrial Average stock.
A committee made up of three representatives from S&P Dow Jones Indices and two from the Wall Street Journal meets twice a year to consider if any changes are needed to the Dow index.
There are no explicit numerical requirements that companies must meet for their stocks to become part of the index. But there are broader, qualitative benchmarks for Dow companies, according to Jamie Farmer, managing director at S&P Dow Jones Indices.
A company needs to have a strong reputation, have a history of weathering economic storms, and its shares need to be widely owned by investors, he said. Companies on the Dow also need to get a lot of their sales from the U.S. — at least a plurality, Farmer said. The companies also generally have to trade on the New York Stock Exchange or the Nasdaq.
What Is The Dow Jones Industrial Average’s Origin Story?
“Dow” is for Charles Dow. “Jones” is for Edward Jones. The two were journalists who founded Dow Jones & Co. in 1882, along with another reporter, Charles Bergstresser. In 1889, they created the Wall Street Journal. On May 26, 1896, the Dow Jones industrial average began measuring stocks — at first, only 12.
“Its initial purpose was really just kind of an editorial function,” Farmer said. “They wanted a way to describe what was going on in the stock market on a daily basis.”
That wasn’t always easy in the U.S. stock market’s early days.
As Charles Geisst’s book “Wall Street: A History” describes, prices for transactions on the New York Stock and Exchange Board, founded in 1817, weren’t always public, let alone available to the area’s newspapers.
Regulations were also flimsy. Markets were easily manipulated. The 1800s were marked by cycles of wild speculation, panic and bank implosions that swallowed the economy — a process that played out multiple times over the century. Predatory tactics abounded.
The daily publication of the Dow Jones industrial average numbers helped investors follow stock market movements more clearly, easing some investor fears, Geisst writes.
What Does The Dow Jones Industrial Average Represent?
And just what is the Dow Jones industrial average’s justification for being “industrial” and an “average”? That’s a little more complicated.
When the Dow Jones industrial average first launched, the 12 companies that it tracked were companies in the industrial sector: American Tobacco, Tennessee Coal & Iron, U.S. Leather, U.S. Rubber. General Electric was on there too, initially, before it was removed from the index and later restored in 1907, before ultimately getting removed again in 2018.
Many of those companies were broken up, absorbed by others, or morphed into different businesses over time.
In the beginning, the Dow was a pure “average” of the stocks in it. The prices of those 12 stocks were added up, divided by 12, and then you got the singular price for the whole thing.
Today, that’s not the case. The Dow uses a mechanism called a “divisor” to help calculate that singular, representative price of the index’s stocks. The divisor is there to smooth out the bumps in price that come from things like stock splits or the addition or removal of stocks from the index. The Dow is also price weighted, meaning higher-priced stocks have a bigger influence on the index than lower-priced ones.
What Is The Dow Jones Industrial Average’s Evolution?
Over the decades, the Dow has become less “industrial,” per se, though it includes big names like GE, 3M (MMM) and United Technologies (UTX). But the index has evolved to include large tech and financial-services players, which are more representative of the economy today.
In the prior tweak, DowDuPont replaced DuPont in Sept. 1, 2017, according to S&P Dow Jones Indices, after it merged with Dow Chemical.
Before that, Apple replaced AT&T (T) on March 19, 2015. And on Sept. 23, 2013, Goldman Sachs (GS) replaced Bank of America (BAC); Visa (V) replaced Hewlett-Packard, which split up; and Nike (NKE) replaced Alcoa, which also split up.
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